Gift-giving and Federal Income Tax

01Dec '15

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Throughout the year, many of us give and receive gifts with no thought to the tax benefits and consequences for the person giving the gift (the donor) and the person receiving the gift (the donee). Gift-giving can be a good estate planning tool for passing wealth to the next generation and a means of intentionally reducing the amount of the donor’s estate. The general rule is that all gifts are taxable to the donor, however, there are many exceptions to that rule.

Furthermore, while some gifts may not be taxable, they must be reported (which means you must let the IRS know you received that gift). The following are not taxable gifts:

• Gifts that are not more than the annual exclusion for the calendar year, currently $14,000 (explained below);

• Tuition or medical expenses you pay for someone (when paid directly to the service provider);

• Gifts to your spouse; and

• Gifts to a political organization for its use.

Annual Exclusion Amount (AEA)
The AEA is a federal limit set by the IRS which allows each person to give another person up to $14,000 each year without having to report the gift. The purpose of the AEA is to record the amount of gifts throughout the donor’s lifetime. Married couples may combine that amount and give $28,000 per person. The AEA is adjusted each year for inflation. The annual exclusion for 2014 and 2015 is $14,000. If a donor gives more than the annual exclusion amount to a person or a child, then the donor must file an Annual Gift Exclusion Return, Form 709.

The Federal Estate Exemption (“FEE”) is the threshold for estate tax; the deceased’s estate pays a federal income tax if it is above that threshold, which is $5,430,00 for 2015. The donor’s FEE is reduced by the amount over $14,000 filed on each AEA return. Thus, there is no immediate tax to the donor for filing the AEA, unless the donor has exhausted the entire FEE. This is great news for many of our readers because if your gifts do not exceed $14,000 per person per year, you are probably giving yourself more flexibility to dispose of your estate while you are alive. Smaller limits may apply at the state and local tax level. Therefore, you should check the estate exemption limits at the state and local level.

A simple way of stating this is that each person is allowed to give up to $14,000 per year, anything over that amount is deducted from your FEE amount. There is no immediate tax to the donor, however, when the donor dies and the donor’s estate PLUS the AEA that have been filed over the years exceed $5,430,000 (or whatever the FEE amount is when the donor dies), the donor’s estate will be taxed on the amount above the $5,430,000.

Gifts from Foreign Persons to US Persons
The AEA does not apply to foreign donors. However, if an American person receives a gift from a foreign individual that is in the amount of $100,000 or more, he or she must report the gift on Form 3520. Again, this is only for reporting purposes and the gift is not taxed to the person reporting it but there are significant penalties for failure to file Form 3520. Gifts valued at more than $13,258 from foreign corporations or foreign partnerships must be reported.

The $100,000 threshold is per person for unrelated individuals. For example, if you receive $99,000 from two unrelated people, that is a total of $198,000, but you do not need to report on Form 3520. However, you must aggregate gifts received from related parties. For instance, if you receive $50,000 from your (foreign) parents and $80,000 from your (foreign) grandparents, the amounts are aggregated to $130,000. Because $130,000 is above the $100,000 limit, you must report the gift.

In conclusion, gifts are a common area that implicate tax law. With the right strategy, donors planning gifts can reap tax benefits instead of merely facing consequences.

Please note that this article is a general summary of law and omits many important details, footnotes, and caveats. It is no substitute for legal advice from a lawyer based on your particular circumstances. Art Steele is an experienced tax attorney equipped to help you include gift-giving as a part of your estate plan. If you expect to give or receive a large gift, contact us at (703) 828-7023.